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Bursting the bubble?

With house prices in Dubai rising by nineteen percent last year, many have been fearing the return of a property bubble. The central bank’s move to put a cap on mortgages aims to change all that, but is the announcement too much, too soon?

A UAE Central Bank circular issued on 30 December capped mortgages for expatriates to 50 percent of the value of the property.

By Claire Valdini

Sun 13 Jan 2013 09:47 AM

Alan Akerman * had been putting the final touches to his plans for New Year’s Eve in Dubai. With his wife and six friends, they would head to the Burj Khalifa early in the afternoon on December 31st, in the hope of claiming a prime spot for what was being billed as the greatest fireworks display in history, to take place on the stroke of midnight.

Akerman never made it to the Burj Khalifa, but had his fair share of fireworks hours earlier. “I heard rumours about 10am, and then saw it on various websites. To be honest, I was in a state of shock, trying to work out what this will mean for us, not just today, but for many years to come.”

Akerman, like thousands of other expats in the emirate, had recently been finalising the purchase of his dream home in Dubai, a three-bedroom apartment in Dubai Marina for $630,000. With his wife, he had spent the last few years saving the 20 percent deposit required, with his bank agreeing to mortgage the rest.

But a UAE Central Bank circular issued on 30 December changed all that, capping mortgages for expatriates to 50 percent of the value of the property for the first home and to 40 percent for the second.

“For us the equation is simple. I now need to find $315,000 to buy my house, rather than $126,000. I don’t have that kind of money. I never will. The deal is off,” he says.

Deal off for Akerman, but it may still be game on for the real estate sector. Long term, the destructive property cycle of boom and bust may have finally been quashed. With fewer buyers on the market, the rental sector is set to benefit, and investors may also focus on lower priced properties, giving that sector a much needed boost. And if the central bank has been modelling its decision on similar moves in Hong Kong and Lebanon, then it could signal a historic turning point in the real estate industry — for the better.

The roots of the decision lie, of course, in Dubai’s astonishing white-knuckle ride in the final years of the last decade. After a law was passed in 2002 that allowed foreigners to own property in certain areas of the city, investors and end-users entered the market in earnest, buying up large tracts of what was — at the time — cheap housing.

Between 2006 and 2008, the property market soared. As government money poured into ever more grandiose projects, queues building up outside developer sales offices became a common sight. Flippers — the short-term investors who bought up off-plan properties and sold them on for as much as 20 percent profit in a matter of hours — made millions of dirhams on properties that only existed on an architect’s drawing board.

In Dubai, the number of real estate transactions almost doubled between 2006 and 2008. According to data from the Dubai Land Department, nearly $900m worth of –— mainly non-existent — property changed hands in 2006; this figure rocketed to $3.8bn only two years later. When Lehman Brothers collapsed in 2008, property prices stood on the edge of a precipice; when Dubai World made its debt standstill announcement to global markets in 2008, they went into freefall.

In retrospect, Dubai’s rollercoaster ride bore all the hallmarks of a classic property bubble — cheap finance, a bulging offplan portfolio, a high percentage of investors as opposed to end users and, of course, prices that were going stratospheric. With values rising by almost 20 percent last year, and memories of 2008 becoming ever starker, the central bank will be keen to nip such inflated growth in the bud.

One of the main reasons behind real estate’s return to form in 2012 is that of Dubai’s safe haven status amid regional turmoil. A government announcement for a multi-billion-dollar tourism and retail development called Mohammed Bin Rashid City in December, coupled with a boost in tourism and retail spending, also helped boost optimism in the market. The upbeat mood in the market and the importance of real estate to Dubai’s economy — it contributed around 13 percent of GDP in 2011 — has led to concerns that another property bubble may form.

The increase in real estate prices has certainly helped lenders revive mortgage lending. Mortgage credit increased 4.4 percent in the second quarter of 2012 to AED11bn ($2.9bn) compared to the same period the previous year, according to data from the central bank.

Mortgages are an important form of financing for expatriates looking to purchase property, accounting for 66 percent of total registered transactions in Dubai during the first quarter of 2011 — the most recent figures available on the Land Department’s website. Foreigners, who account for around 80 percent of the UAE’s population, are major property owners and buyers, snapping up real estate assets worth AED28.3bn ($7.7m) in the first half of 2012.

While a mortgage cap may limit end users from buying, it will take the heat out of the market in the short term, says Craig Plumb, regional head of research at Jones Lang LaSalle (JLL).“It is much better to see two to three years of growth at ten percent than one year of 30 percent because that’s more likely to be followed by a collapse the next year so from that point of view it’s a positive. It’s a good sign that the central bank is taking this seriously,” he says. Property prices are likely to slow down as demand falls in the wake of the regulations, he adds.

Although the Land Department figures show two thirds of property transactions were mortgages, the actual number of people taking out mortgages is lower and therefore unlikely to affect prices, according to Nicholas Maclean, Middle East managing director of global real estate consultants CBRE. “The mortgage buying section of the buying community is relatively small — we think it’s between 20-30 percent — so the majority of the market is unaffected. I don’t see this having a major impact on the marketplace but I do think it’s going to have a stabilising impact on the market,” he says.

But not everyone sees it that way. While the new regulations will ensure that the country’s property market grows at a more reasonable pace than it has done in recent years, they could also hurt its recovery. The speed at which the announcement was made also highlights the risks of doing business in an unpredictable environment.

Speaking to reporters last week, Nakheel’s chairman, Ali Rashid Lootah, said: “the new mortgage cap won’t affect those buying high-priced luxury properties as they will be financially capable of placing a higher down payment, but it will impact the middle class people... it could be restrictive.”

“We expect that this regulation will help control speculation in the UAE property market, however, the severity of it could also hurt the genuine investors and end users as well,” says John Chang, head of consumer banking at Dubai’s Noor Islamic Bank.

“The property market will be pulled down significantly as a result of this regulation. In the short to medium term, prices will come down as the market shifts from a sellers’ market to a buyers’ market,” he adds.

Others fear that a mortgage cap will end up hurting the end users rather than speculative buyers. “Most of the investors who are driving up prices are cash buyers. Investors don’t use mortgages, those are taken by the genuine users,” says Kabir Mulchandani, CEO of Dubai-based real estate investment firm Skai Holdings.

He adds: “If this regulation continues, rents will go up because end users cannot come up with 50 percent. It will lead to more investors owning property than end users.”

That said, there is a feeling amongst some experts that the lower priced end of the market will benefit — a view the stock market appears to back. Take Emaar shares, which are now trading at over AED4, representing a remarkable 70 percent rise in the last twelve months. Back in November 2011, the company announced a strategic move into low-cost housing across the region — beginning with Dubai. At the time, Emaar chairman Mohamed Alabbar told Arabian Business: “We’re talking to a few emirates. I’m going to focus on Dubai to start with. We are talking about [property] of maybe AED550,000 for someone with an income level of around AED12,000 a month.”

In theory, it means those who hope to buy a AED2m home may be forced into looking at far cheaper options, boosting companies like Emaar.

Though other experts argue that just because people can only afford a AED2m home rather than a AED4m home doesn’t mean they will now buy cheaper homes.

“Because there is a flight to quality in terms of location and structure, I think in some locations — particularly those locations further from the centre of Dubai — they will either be stable or show a slight decline until we have a meaningful increase in terms of people in the market place. If we start to see growth in the overall population here all of the sectors will be affected positively but until we see that growth in population we’ll still see some declines in the less-quality property,” says Maclean of CBRE.

The mortgage cap follows other directives aimed at tightening the UAE’s financial system in the wake of the downturn. The central bank in April issued new caps on lender’s exposure to state-backed institutions at 100 percent of their capital and 25 percent to any one state-related entity. The move was postponed pending a review.

UAE bankers are hoping a similar review is conducted before the mortgage cap is standardised. With no prior warning that the regulations were going to be imposed, bankers are concerned about the impact the mortgage cap will have on lending and liquidity.

Last week, local lenders asked the central bank to delay the introduction by 30 days and are said to be planning to speak to it about raising the new loan-to-value lending limits. “It was agreed that the Emirates Banks Association will write to the central bank requesting a 30-day delay for implementation of the circular,” one source with knowledge of the matter told Reuters.

While sources say bankers are generally comfortable with a mortgage cap, most reportedly favour a loan-to-value cap of around 70-85 percent with higher limits for UAE nationals and lower for foreigners.

“Everybody is shocked [at the announcement]. Most banks already ask for a 30 percent loan-to-value but if you tell foreigners they cannot buy a house unless they have a 50 percent down payment they won’t want to buy a house,” one senior banker tells Arabian Business on condition of anonymity.

“They could have restricted the foreigners who are non-residents with a 50 percent cap but not those with a residency. Local banks are likely to be the most affected as they rely on retailing banking and mortgages. Retail is their bread and butter,” he adds.

Others argue that the UAE authorities should look at implementing a mortgage law rather than a cap, which only serves to reduce the liquidity in the property sector, “It will restrict the risks taken in the banking sector but it means the property and real estate sector still lacks the finance,” says Nasser Saidi, managing director of Nasser Saidi & Associates.

“We have to find other ways of financing a very important sector for the UAE economy and this [move] hasn’t answered that question,” Saidi adds. “The answer is through the development of a proper mortgage market; the securitisation of loans and specialised mortgage lenders.”

But the decision by the UAE central bank to implement a 50 percent cap on mortgage lending to foreigners is not unprecedented.

Take Lebanon — there, the banking system and economy thrived as the global economy slumped largely because its central bank governor Riad Salameh regulated the activities of banks, with measures adopted as early as 2001 and 2004, banning them from investing in derivatives, foreign structured products and thus helping avert a similar pattern to the unfolding subprime crisis in the US.

The Lebanese central bank also implemented a cap on mortgage lending forbidding Lebanese banks to finance more than 60 percent of the value of the property being purchased in order to avoid a speculative real estate market and bubble.

“The Central Bank of Lebanon’s decision was meant to put discipline among developers and avoid speculation by ensuring that developers are building projects on a sound basis rather on having access to easy and cheap funding,” says Nassib Ghobril, chief economist at Byblos Bank in Lebanon.

The Lebanese central bank took this measure during the property boom in the country which was spurring economic growth and though its objective was to curb any potential speculative behaviour by developers it did not help move the market towards rental, Ghobril says.

About 90 percent of residential demand is from Lebanese nationals while foreign demand accounts for ten percent. Foreign demand has been decreasing. In 2011, the number of sales to foreigners dropped by 20.3 percent, after rising an average of ten percent per year, during the previous five years. Lebanon registers between $7bn and $10bn in annual real estate transactions.

“During the boom years the intervention of the central bank was to limit people just borrowing money to speculate,” says Raja Makarem of Ramco Real Estate Adviser. “Definitely it’s the role of the central bank to limit the speculation. In Europe, it could go up as far as 100 percent and this is what damaged the international real estate market — the over borrowing. Putting limitations on how much one can borrow definitely does influence and control the extent of speculators.”

The UAE’s 50 percent cap on mortgages “aims to avoid speculation in the real estate market, now that the market has bottomed out and is recovering. I believe authorities have learned from the experience of recent years and want to avoid a repeat of what happened in the late 2000s, which is wise,” he adds.

The central bank announcement also comes hard on the heels of attempts to prick another gigantic housing bubble, this time in Hong Kong. The city state’s previous property boom reached its previous peak in 1997 — the time of the UK’s handover of Hong Kong to China — before prices slumped by 70 percent until August 2003. In the ten years since then, prices have rebounded by an astounding 240 percent, helped by wealthy buyers from the Chinese mainland, a lack of supply in what is already one of the most highly populated cities in the world, and low interest rates helped by the Hong Kong dollar’s peg to the greenback.

Mindful of the Dubai experience, local officials have tried every trick in the book to rein in prices. In 2010, in a bid to prevent investors making a quick buck from house purchases, the government put additional stamp duty on houses that were sold within two years of purchase. Two years ago, the central bank raised the minimum down-payment for mortgages costing more than HK$7m ($902,000) to 40 percent. Those moves put the brakes on in late 2011, as house prices fell briefly. But in 2012, values rebounded faster than ever, with property rising by fully 20 percent over the course of the year.

In September last year, Hong Kong’s chief executive, Leung Chun Ying, outlined a ten-point plan to cool the market. In addition to the previous regulations, Leung limited the maximum term on all mortgages to 30 years, while mandating that mortgage payments cannot make up more than 40 percent of buyers’ incomes. The central bank also ordered that non-Hong Kong-based investors needed to put down fully 70 percent of the value of the property. Then, in October, officials introduced a fifteen percent stamp duty on sales to non-resident buyers, and upgraded the tax on properties sold within six months to 20 percent.

In Singapore, where private home prices have leapt by 59 percent since 2009 — that’s the beginning of the global financial crisis - the government has tried similar measures. Additional stamp duty has been introduced for some buyers, with foreigners facing the biggest squeeze, while authorities have raised down-payment thresholds and made more cheap land available for developers.

It’s too early to say whether those measures have brought some degree of control to the market, but investors have already shifted their attentions to one less-regulated area of real estate: parking spaces. The average cost of a parking space in Hong Kong is now just shy of $100,000, up 20 percent from a year previously. And with banks actually offering mortgages on parking spaces, even these are gaining interest from flippers — transactions in 2012 were up by 500 percent over the course of last year.

So what lessons can Dubai take from Hong Kong and Singapore? Unless the UAE moves to implement stamp duty, which would be a major break from its status as a zero-tax haven, then its options are few. One option could be to raise the fee that the Land Department collects during every transaction (around one percent), although this would need to be a substantial hike in order to make much of a difference. The central bank could also limit how much each investor pays back, as a percentage of their monthly salary, as it has already done for personal and car loans.

Regulators in the UAE have a fairly limited armoury; as the dirham is pegged to the US dollar, interest rates cannot be raised.

For investors and home buyers however, regardless of macroeconomic policy, confusion reigns for now. HBSC is believed to be giving customers with pre-approved mortgages until the 24th of January to complete purchases. Noor Islamic Bank has confirmed it will honour existing pre-approved mortgages, while others such as Abu Dhabi Commercial Bank and Standard Chartered are thought to be offering differing deadlines to different customers.

Exactly what the position is and what the long-term outcome is, only time will tell.